The doves have come out in full force. No, not at the local aviary or the park, but in the chambers of the Eccles Building in Washington, D.C.—the home of the U.S. central bank, the Federal Reserve.
With tax and trade policy high on the agenda of the Trump administration, monetary policy has not been at the front of the financial news. Analysis and forecasting of Fed decisions has nonetheless quietly exerted its sway over the markets. U.S. equities are still riding the "Trump rally" even with the election more than three months behind us. Even after the fed funds rate was raised another quarter-percent (25 basis points) in December, followed by increasingly hawkish comments from Fed officials leading into the March FOMC meeting.
Talk That Isn't Cheap
Despite all of this talk of higher rates, both stocks and safe havens like gold have performed well in 2017. In theory, neither of these things should happen for very long if higher interest rates are on the horizon. (Gold actually does well at the beginning of a period of climbing rates, however.) Although it is a relatively brief snapshot, the market behavior we've seen to start the year would imply that either Wall Street is completely discounting the impact of tighter monetary policy (i.e. rates going up) or that the exuberance shown by investors is topping out as it approaches exhaustion.
Or, there is a third possibility: The smart money is pricing in a much less aggressive path for interest-rate increases. As in virtually no increase, and thus a longer period of accommodative policy from the Federal Reserve.
By most of the government's favored measures, the economy is finally beginning to hum along, so why shouldn't we all expect interest rates to be on their way up? What about all of the hawkish talk by those who shape monetary policy? Not only has this been tempered by a number of comments from other Federal Reserve Board members making the exact opposite case, but it is yet another example of the Fed following a protocol that goes back to at least the Greenspan era: Fedspeak.
- The first rule of Fedspeak is that you never talk about Fedspeak.
- The second rule of Fedspeak is that the first rule may routinely be broken.
Kidding aside, there is really just one guideline of Fedspeak: Use ambiguity and equivocation to reveal as little substance as possible about what the central bank plans to do. While serving as the central bank's chair, Alan Greenspan wielded this rhetorical tool to devastating effect. A confusing and obscure statement was much less likely to elicit a reaction from the markets.
Current Fed Chair Janet Yellen has deftly introduced her own twist to this strategy. When she must lean in one direction or another—even if only slightly—on a policy issue, she generally chooses the side that's contrary to what the bank is actually most likely to do. This is a subtle yet powerful way to influence market expectations to the Fed's advantage.
When the FOMC has actually pulled the trigger on higher rates in December of each of the last two years, Yellen has emphasized the reasons to keep rates low: She mentioned the murky global economic outlook and headwinds from overseas risks as causes for caution in 2015; she cited the uncertainty of the new presidential administration's policies as having a similar influence after the 2016 rate hike.
Now, consider that Yellen and most other FOMC members are emphasizing the points in favor of raising rates. The release of the January FOMC meeting minutes this afternoon supports this being the case. Think about what that usually portends. We may end up a far cry from three or four rate hikes this year as the bank shifts toward more dovish decisions.
More Loose Monetary Policy?
It's also interesting to look at the minority opinion within the central bank. Both San Francisco Fed President John Williams and newly minted Minneapolis Fed President Neel Kashkari have expressed their view that interest rates ought to kept lower for longer. Kashkari not only revealed that he voted against the December rate hike but also opined that there's no clear evidence that raising rates gradually (at the risk of raising them too soon) is necessarily preferable to waiting too long (at the risk of being forced to raise them quickly).
Simply put, these practices by Yellen and others at the Fed have the effect of minimizing market disruptions that might come from policy being telegraphed too clearly ahead of time. This is a reasonable desire for an institution that prides itself on being "politically independent," but in effect it is a mandate to not say anything that would adversely impact the stock market.
This de facto Fed objective is not difficult to believe in light of how Congress has progressively empowered more companies from more industries to sue individuals and organizations whose public statements may contribute to a negative effect on their stock price. For better or worse, the relationship between big business and government institutions is always cozy.
The possible politicization of the Federal Reserve by the White House is a looming risk, however. Might President Trump appoint someone from the world of Wall Street to the Fed, as he has done with the Treasury Department and much of his cabinet? What policy changes might Trump push for?
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.